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The Gates Open

WASHINGTON — Life is starting to get a little easier for foreign companies looking to sell their brands in China, as that country begins to lift some of the legal barriers they faced.<BR><BR>As part of its World Trade Organization commitments, in...

WASHINGTON — Life is starting to get a little easier for foreign companies looking to sell their brands in China, as that country begins to lift some of the legal barriers they faced.

As part of its World Trade Organization commitments, in December China changed its law to allow foreign companies to open wholly owned retail operations within the country. Previously, they had been required to sell a stake in their Chinese ventures to local investors.

Even with the barriers in place, major U.S. firms, including Wal-Mart Stores Inc. and Nike Inc., have worked their way into the Chinese market, finding the allure of 1.3 billion consumers too much to resist.

U.S. officials and executives called the recent changes positive, but warned that foreign companies still face a thicket of regulations from China’s 22 provincial governments that can slow their entry into the market. A wide gap exists between the central government’s pronouncements of changes in business laws and the implementation of the formal regulations to carry it out.

“China did issue regulations that looked good on paper…but we haven’t seen the follow-through and we’ve been pressing China on this to make sure the process works properly,” said a U.S. trade official, who spoke on the condition of anonymity. “Foreign companies that establish in China are trying to work their way through the bureaucracy with the help of the U.S. government to find out how to obtain their new rights.”

The trade official claimed the government and private sector are in a “start-up period and encountering some bumps.”

“We’re spending a lot of effort on these issues to get rid of these bumps but the process isn’t completely functional.”

Many experts claim it will be years before barriers to China’s market are fully dismantled, as local governments continue to impose burdensome rules on foreign firms.

Among the concrete changes that the central Chinese government has made recently:

Foreign retailers are now allowed to operate an unlimited number of stores in China and own 100 percent of their Chinese venture. Previously, single-brand and multibrand retailers had to sell a stake of their business to local investors.

This change is of particular importance due to a peculiarity in the way the Chinese retail industry operates. Chinese department stores are modeled more on U.S. shopping malls than on U.S. stores — the Chinese chains don’t buy and sell goods, but rather lease space to brands, which are responsible for manning the space and selling their wares.

One important exception to the rule is that foreign retailers that have more than 30 stores selling certain sensitive products, including chemical fertilizer, coffee, sugar, grains and refined oil, have to sell a majority stake in their business to local investors. Apparel is not on the list of sensitive products, according to the U.S. trade official.

Foreign companies are now allowed to own their distribution centers and distribute goods produced outside of the country.

Foreign companies can now produce goods in China to sell to the Chinese market. Previously, foreign companies that manufactured in China had to have hard-to-obtain licenses to sell to the domestic market. That barrier, coupled with China’s 30 percent duties, made it difficult for foreign brands to sell in China.

“There are some important unanswered questions in those regulations and we are pressing China to clarify them,” the trade official said. “We have had a lot of exchange with the Chinese government on this and we are trying to fix the problem but we are not there yet.”

Frank Badillo, senior economist at consulting firm Retail Forward Inc., said, “A lot of formal barriers are being eliminated as China complies with the WTO, but informal and political barriers remain…Domestic companies seem to have the advantage of getting government approvals over foreign companies, even though on paper China is prevented from treating foreign operators differently.”

He said it appears the Chinese government is still trying to protect domestic retailers to ensure they remain competitive against foreign operators.

Badillo noted that Wal-Mart has operated in China for years despite the hurdles and created a successful model through joint partnerships. To illustrate the difficulties in cutting through China’s red tape, he noted that the Bentonville, Ark.-based company in mid-2003 disclosed plans to open stores in Shanghai.

“Eighteen months later, they are only now getting formal approval to open stores in Shanghai,” Badillo said. “It’s clear Wal-Mart found it difficult to get regulatory approval over the past 18 months.”

A spokesman for Wal-Mart said the company has taken advantage of one recent change in China’s business laws that prevented it from building stores in certain communities.

“We have a lot more flexibility in where we choose to build stores,” he noted.

Wal-Mart, which operated 43 stores in China at the end of 2004, plans to continue operating with joint venture partners in China this year and build an additional 15 to 20 stores, according to the spokesman. Wal-Mart has no plans to terminate its relationships with joint partners.

“We have said we intend to continue [joint ventures] because it is helpful to us and our partners are Chinese and understand the business,” he said.

Badillo said Wal-Mart’s Chinese partners find locations and develop properties around the country, which is half the battle in terms of expansion.

The Wal-Mart spokesman said the firm holds trade fairs through its own U.S. export office to help U.S. brands make forays into international markets through its stores.

“We hold trade fairs and invite area suppliers to come in and talk about what they make and what countries they might be interested in,” he said. “A lot of times smaller companies just don’t know how to do it because it is so complicated…What we found is that some companies have been able to start out with us [in foreign markets] and the expertise and knowledge they gain enables them to take the next step to not only sell in Wal-Mart but in other stores, as well.”

Apparel manufacturers, many of which source in China but export everything they make there, are also closely watching how China implements its new laws and issues regulations.

Kevin Burke, president and chief executive officer of the American Apparel & Footwear Association, said U.S. companies are assessing the prospects of selling to the Chinese market. He noted that while Chinese law now allows U.S. branded products to be made and sold in China, the government has not issued regulations instructing local governments how to allow foreign companies to sell apparel locally.

“There is a concern that without regulations on the books, there is the risk the Chinese government will say you can’t do it that way and fine you or force you to ship the goods back to the factory,” said Burke. “Our hope is that the Chinese government will quickly institute regulations on distribution rights to give guidance to members who produce in China and want to sell in China.”

In addition, intellectual property violations are rampant in China and many companies are reluctant to expose their brands in the market, Burke said.

China presented an “action plan” at a joint U.S.-China meeting last April to address the intellectual property problems in China. It calls for improved legal measures to facilitate increased criminal prosecution of intellectual property violations, increased enforcement activities and a national education campaign.

Nike is one of a few U.S. apparel and footwear companies that has been selling to the Chinese market since the mid-Nineties.

“We have been expanding our retail presence in China,” said a Nike spokesman. “It is the fastest-growing region for us in the Asia-Pacific.”

Nike product is sold in about 1,500 locations throughout China, of which 1,000 stores operate as Nike-only managed space. “We are very pleased with our growth in China,” the spokesman said. “We are opening 1.5 doors a day.”

He said Nike executives have cited China as the key growth driver for Nike in Asia-Pacific in fiscal year 2004 and the first half of fiscal year 2005, which ends in May. Nike’s second quarter revenue in China doubled year over year, he said.

Liz Claiborne Inc., on the other hand, has limited experience in China and relies on a Chinese partner to distribute its Mexx brand, according to Jorge Figueredo, president international at Liz Claiborne.

“We have a partner in China that really handles all of the logistical challenges in the Chinese marketplace,” said Figueredo.

He drew a parallel with Europe when explaining the difficulties associated with distributing product from one region to another.

“Every region in China has its own laws, regulations and customs practices. There are climate differences, cultural differences and consumer preference differences,” said Figueredo. “To be successful in China, you need a series of partners to understand each region’s difference.”

The Mexx brand for the past two years has been sold in department stores, primarily in shops within shops, in Shanghai and Beijing, he said.

“We view China with great interest but we’re really in a more studying stage,” Figueredo said. “We do believe it will be a significant market over time but clearly it’s in the beginning stages.”

He noted the repeal of restrictions has resulted in an influx of more international brands in China that set up their own shops, largely with Chinese partners.

“As China gets more engaged in the international community and as the business community gets more interlocked, I think things will continue to progress,” he said. “We will see a further revolution and perhaps at a quicker pace.”